Many people think that the Austrian school is in favor of a gold standard but, this is not entirely true. While the Austrian school would say that reinstating a true gold standard would be profoundly positive for the economy (ending the boom-bust cycle, inflation, trade imbalances, malinvestments, and making for a much more prosperous society), they would not ultimately support it as an end goal.
First, it is important to understand how money arose in the first place. Money arose naturally in the free market through trade. Direct trade obviously does not lend itself to be very handy when I have something that no one or, only a few people want. If I raise cows and want to buy a pair of socks, I have to find someone who has socks who will trade for my cow. Most likely they will not have enough socks or more socks than I need for the cow, thus making direct trading very inefficient. Every social order arises with some medium of exchange very early on. At first it just needs to be a good that is widely demanded. So if I have the same cow, I can now trade it for apples, which in this example enjoy wide demand throughout society. With these apples I can now go to anyone and buy any good or service because apples are widely known to be high in demand. Now I can sell my cow for a couple hundred apples and give the guy with the pair of socks maybe a dozen of them. He can then go and sell his apples and buy something that he wants while I will have apples left over to buy more items for myself. Apples now have become a “medium of exchange” but ,they would not be considered money under the Austrian definition as I will explain later. Examples of mediums of exchange naturally coming into existence are common, with the most obvious example at the top of my head being cigarettes in prison being used for trade (whether these prisoners are using a more honest “money” than the Federal Reserve is another matter!)
As a society becomes more complex, apples become insufficient as a medium of exchange. Apples rot, apples are fairly common (have low value per unit), and the supply of apples changes greatly from season to season. If apples were the best thing out there for a medium of exchange, we would likely use them, even in today’s complex society. Luckily, nature offers us a much better medium of exchange, precious metals, specifically gold and silver. Gold and Silver naturally arose in the free market by the hand of free acting individuals. When a society starts using precious metals it has finally crossed the threshold from a medium of exchange into “money”.
Money must have certain properties:
1. Value in itself- A society must widely accept whatever good that is used for money as valuable. Even if it was no longer used as a medium of exchange it would still be desired by a large amount of people. This is why Federal Reserve notes are not “money” but are instead currency, because they do not have value in themselves.
2. Homogeneous- money must be easily divided with all parts being the same thing. This is why land or diamonds do not make good money(the value of land varies greatly from place to place and each diamond is different and must be appraised individually).
3. High Value per unit / scarce- Money must have a high value per unit. This is why water does not make good money, even though it is critical to life, it is relatively abundant.
4. Easily Transportable – Money must be easily exchangeable and must be able to be easily transported. This also relates to “High Value per unit.” It is much easier to move $10,000 of diamonds than $10,000 of iron .
5. Durable- It must not be able to rot like seeds, apples or tobacco. It must be stable and able to last for years without corrosion or rot.
6. Relatively Stable Supply- Money can not change in supply by large amounts because of its critical role as a “unit of account”. Basically, long term capital investment projects require money that stays at a stable value over time in order to calculate financial costs over many years. Any growth in the supply of money should be predictable over time (this is one of the reasons gold can be used as money, its supply grows at a steady rate of about 2% per year)
As we can see, money naturally arose through free acting individuals. So how did we come about to having a “gold standard”?
The dollar is a good example of how free market money gradually became subverted by the government. A brief history:
The “dollar” began in sixteenth-century Bohemia as a one-ounce silver coin minted by the Count of Schlick, who lived in Joachimsthal. The coins were called Schlichtenthalers. This was shortened to “thalers” and when the coins made their way into Spain, the coins became known as “dollars”.
The Spanish milled Dollar was a silver coin carrying the name Dollar and having a weight in silver of approximately 368 to 374 grains of fine silver. The Spanish Dollar, was the most common coin in circulation in the colonies prior to the American Revolution. In other words, the medium of exchange selected by the free market, became the Dollar of the United States. A silver coin of 368 to 374 grains of fine silver is what the word Dollar means as used in the Constitution. The Constitution and the law at the time merely codified what was already commonly accepted by the people of the United States.
There is some controversy whether gold arose as money naturally in the free market or whether it was a result of government intervention. What is known for certain is that gold arose during the 19th century United States when there was heavy government intervention into the monetary system. For simplicity’s sake, we will suppose that gold arose on the free market.
By the end of the 19th century, all the governments in the world were on a gold standard, all money was valued in gold. (It is important to point out that there were other moneys in circulation like silver and copper in coins but they were not valued in their weight like in the past but rather in whatever monetary unit a nation used, like dollars for example. This created distortions in the monetary system. We will skip over this for simplicity’s sake.) So the dollar would be a measurement in weight of gold, specifically 20 dollars could be exchanged for an ounce of gold, or 1 dollar would be 1/20 of an ounce of gold. The same was true for all of the other currencies in the world. One hundred Franks could be exchanged for an ounce of gold. Same for German marks or anything else. So the whole world was in a defacto gold standard. Even though each country called their money by a different name, it was simply a weight measurement of the same good, gold. To give people an idea of how stable the world’s money supply was, there were hundred year bonds issued by private companies in the beginning of the 20th century and global trade, as a percentage of the global economy, was higher than it is today!
Then the largest disaster in world history happened, World War I, Pax Britannica finally ended in a bloody inferno. What used to be a sacred contract, the ability of the people to redeem their paper notes in hard specie, was “temporarily” suspended. Every Western nation had their economies and monetary systems hijacked by their respective central governments. Today, it is known as Total War or War Socialism. Basically, the idea was that every ounce of the economy of each waring nation would be outright nationalized or remade in the fascist economic model (property remains private in name but, it is totally controlled by the government) by the central government in the “war effort.” In summary, it was not enough to take over industry, the monetary system of each country had to be undermined as well. Simply put, their was no way to pay for the war through taxes, the populations of the waring countries would have likely rebelled at such a high cost. So they had to steal it… through inflation. By ending redemption in specie, governments could print as much paper notes as they wanted and have people accept them as money through force. Fraudulent paper notes (they no longer were redeemable, thus violating contract law) were used to buy real material wealth for the war effort. World War I finally ended but not without unimaginable damage. For this article’s purposes, some of the worst damage came in the loss of faith in government contract and future precedent to manipulate the monetary system.
Although the United States never went off the gold standard during World War I because of its relatively late entrance, all the other countries in the Western World going off the gold standard had a profound effect on the U.S. Britain expanded its “money” (paper notes) supply during the war even though it had even less gold in its vaults by the time it was done. The British made a fatal mistake and that was to reinstate the Pound at its “pre-war parity”. That is, the pound after the war could be redeemed for the same amount of gold as before the war even though there were far more “paper pounds” in circulation. Next to the war, this was probably one of the worst decisions in the 20th century (interestingly it was Winston Churchill who most pushed for this because of “British Pride”.) So instead of facing reality and devaluing the pound, they made it seem as though the pound was just as strong as it was before. To pull this off, the Central Bank of England had to convince the U.S. Federal Reserve to inflate the dollar so that the weakness of the pound would not be exposed. From 1925 to 1929, the Federal Reserve did just that. Stocks began to sore and everyone was making money hand over fist because they thought they were wealthier than they were. But this could not last forever. As predicted by a contemporary at the time, Ludwig von Mises, this inflation ended in collapse and later became the Great Depression.
Although Herbert Hoover tried massive stimulus efforts to revive the economy, like the Hoover Dam and other public works, the economy continued heading south (sound familiar?). Hoover’s mistake was that he tried to keep the boom going instead of letting the malinvestments clear out. FDR came in campaigning on returning to the free-market but instead took Hoover’s policies and put them into overdrive. Getting back to the monetary realm, FDR confiscated all gold from the people in the United Sates to pay for his New Deal programs. Gold was revalued from 20$ an ounce to 35$ an ounce but, it was no longer redeemable or even legal to own at all in the United States (the government would not make it legal to own gold again until the 1970s). No longer could people have the comfort of holding gold Eagle coins in their hand, they were at the mercy of whatever the government decided to do with the money supply. So now the government claimed that thirty five dollars was worth an ounce of gold but, people could no longer own gold so this meant little. As we shall see, this quasi gold standard was the beginning of the end.
To fast forward a little bit, when World War II ended, the world came up with a new monetary arrangement known as the Brenton Woods Agreement. The basics of it were simple. The United States would back its dollars in gold and every other country in the world would back their currency’s with dollars. So, the Bank of Japan would keep dollars in its vaults and instead of making Yen redeemable in gold, Japan would make Yen redeemable in dollars. If Japan wanted gold, they would convert yen to dollars, and then they would send their dollars to the Federal Reserve and the Federal Reserve would send gold back to them (or simply put gold in a new pile that was allotted for Japan within the Federal Reserve Bank). It worked like a giant pyramid with gold on top, then dollars on the next level, and then the fast amount of the rest of the world currencies on the bottom. The whole thing holding Brenton Woods together was the “good faith” of the United States; that they would not inflate. The first rule about governments and money, if they can inflate they will, and so the American government did.
The largest inflation came in the 1960’s with Lyndon Johnson’s Great Society program and the Vietnam war. They were not paid through taxes but, instead were paid through inflation (weird huh? Kind of like Afghanistan and Iraq?). Inflation finally hit during the Nixon administration. There were way too many dollars floating in the world and it became obvious that the United Sates did not have the gold to back them up. It was kind of like a bank run with countries as customers and no one wanted to be the last guy to redeem his deposits. This is when Nixon finally closed the “gold window”, supposedly temporarily, because of the crises. It was basically a global default with all the countries in the world being defrauded out of what was owed to them by contract; the gold in the vaults of the Federal Reserve.
Some people call what we have today as Brenton Woods II because we still live in the same system even though their is no gold backing the dollar. The pyramid still works the same but, the dollar is at the top. All the other countries in the world still have dollars in their vaults even though they are no longer redeemable for gold. This is important to understand because many people think that our monetary system was put together by a bunch of wise economic minds but, this is not true. It exists the way it does because Lyndon Johnson and Richard Nixon messed up big time. They inflated too much and the central banks of the world called their bluff. I guess old tricky Dick gets the last laugh since in the end, the joke was on them. They never got their gold They just hold dollars that are redeemable for, well, nothing. Ha ha, what a bunch of suckers!
The government has slowly over time subverted natural money. As you can see, even with a government gold standard, the government was eventually able to find a way to inflate. Most Austrian Economists would like to see the free market in charge of money again and have the government completely out of it. Time and time again, the government has shown itself not to be trusted, so why give them the power again? A government gold standard would be preferable to what we have today but, ultimately it should be the market that decides what the medium of exchange is. Most likely, the market will choose gold and silver if the past is any guide but, maybe not. We simply don’t know for sure. What we do know for sure is that every fiat money system in history has collapsed. The odds are not on the Federal Reserve’s side. For some reason, the bureaucrats in DC don’t strike me as the kind of people that beat the odds.